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The Role of Independent Directors

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  THE ROLE OF INDEPENDENT DIRECTORS By Mahwesh Bilal Khan, IFC “Independence means that a director’s decision is based on thecorporate merits of the subject before the board rather thanextraneous considerations or inuences” Delaware court ruling: Martha Stewart Living Omnimedia, Inc v Stewart  The recent spate of highly publicized corporate governance scandals—starting fromEnron and including the Walt Disney Company, Hollinger International and irbusIndustries, to name a fe!—has resulted in putting corporate governance in a verystrong spotlight These corporate governance failures indicated that the internalchec#s and balances being used by these companies at the time !ere not sufficient The enhanced interest in ho! companies are run and controlled has causedshareholders and investors to demand better and tighter corporate governancestructures These changes have translated in a stricter scrutiny of the compositionand structure of the board, particularly of listed companies and large public$ family%o!ned companies It is in this conte&t, that the role of independent directors on boards of companieshas seen an enhanced value and demand across the globe  recent Standford Law Review   paper suggests that bet!een '()* and +**), the composition of large publiccompany boards in the nited -tates has dramatically shifted to!ards independentdirectors, from appro&imately +*. independents to /). independents ' The moveto independent directors, !hich began as a 0good governance1 catch phrase, has inmany 2urisdictions become a mandatory element of corporate governance la! The 3a#istan Code of Corporate 4overnance, +**+ requires  the 5oard of Directors of each listed company to include at least one independent director   representinginstitutional e6uity interest of a ban#ing company, development financial institution7D8I9, :on%ban#ing financial institution 7:58I9, mutual fund or insurance company + Ho!ever, for the representation of minority shareholders the Code provides a blan#etrecommendation for companies to ; encourage effective representation of independent non-executive directors, including those of minority interests, on their oards of !irectors <=  > , and does not ma#e mandatory a specific number of independent directors on the boards -o the 6uestion that comes to mind is? !hat is it that independent directors bring to5oard that the e&ecutive and$or non%independent directors do not@ The ans!er is6uite intuitive albeit not very straightfor!ard 1.Avoidance of potential conflicts of interest Aanagerial oversight is an important function of a board of directors longside theappointment of e&ecutive members 7those employed by and involved in running day% 1  Gordon, “The Rise of Independent Directors in the United tates, 1! #$%## & 'f hareholder (al)e and toc* Mar*et +rices -%##./, Col)0ia 2aw and 3cono0ics 4+ 5o6 7%7 %  Cla)se i -/ of the Code of Corporate Go8ernance, %##% 7  Cla)se i , of the Code of Corporate Go8ernance, %##%  to%day affairs of a company9, boards have to ensure that there is still an effectiverepresentation of independent members to ob2ectively oversee the management Independence is particularly crucial in those areas !hich involve a potential conflictof interest bet!een managers and shareholders? nomination of the management,managerBs pay and audit of the companyBs performance  itself an indicator of theperformance of the manager sually, presence of independent non e&ecutivedirectors ensures that any material conflict of interest involving directors are properlydealt !ith 2.Protection of Minority Shareholders’ Rights Independent directors have an important role to play in companies !here acontrolling shareholder 7e g , a family holding more than *. shares of a company9has strong control over the management? a typical scenario for the emergingmar#ets In such cases, conflicts of interest may arise bet!een the ma2ority andminority shareholders The presence of a good ratio of independents on the boardcan help ensure that there is enough representative voice of the minorityshareholders on the board for their rights to be !ell protected 3.Exercising Independent !dg ent :o matter ho! !ell meaning the e&ecutive directors may be, more often than not,being involved in the day%to%day affairs of the companies that they !or# for, thesedirectors tend to get myopic The independent non%e&ecutive directors on a boardprovide the much needed ;outside vie!= of things, and e&ercise an independent 2udgment !hen it comes to ma#ing a long term strategy !or# Independent directors are generally sub2ect$ field e&perts ther than merepecuniary considerations, independent directors are li#ely to be motivated by thecontribution they can ma#e to a company through bringing in their o!nachievements, s#ill%sets and e&periences  company can dra! many importantlessons from the e&perience and e&pertise of such independents   5. Investor #onfidence s public information has become more transparent and reliable, investors—especially institutional investors no! clearly prefer companies !ith better governancestandards, over those !hose corporate governance practices may still be dubious Having independent directors on boards sends a very strong signal to investors thatthe company is !ell run and governed, and its board is sound enough to ensure thatnothing less than the very best international corporate governance practices areadhered to $. Independent %irectors as co!nter &alance Effective representation of independent directors on a board tends to balance theboard=s s#ill mi& Whilst e&ecutive directors bring !ith them the organizationalinsight, independent members of the board are generally regarded for their e&pert#no!ledge and ob2ective mindedness Together, a balanced board can steer thecompany to success ne caveat though is that the independence is a state of mindand depends upon the personal characteristics of each individual nd !hile, therecan be !ays of defining ;independence=, at the end of the day a very independentdirector may not be able to e&ercise independent 2udgment n the other hand, ane&ecutive director may be totally unaffected by his position in the company, and ta#etotally unbiased decisions in his role as a board member

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